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J.C. Penney’s Options May Include Sale

In the wake of CEO Ron Johnson's departure, the retailer faces a tough turnaround.

J.C. Penney Co. made a radical break with tradition by hiring Silicon Valley wunderkind Ron Johnson as chief executive officer. With Johnson gone, the chain may have to pursue even more radical options, such as selling itself.

After suffering a 25 percent annual sales decline, J.C. Penney yesterday ousted Johnson, 54, and replaced him with his predecessor, Myron E. Ullman III, 66. Investors, who pushed the shares up 13 percent on news that Johnson was out, abruptly sold after learning Ullman was the new CEO. J.C. Penney dropped 8.3 percent to $14.55 at 7:47 a.m. in New York.

Ullman faces several tough choices. He’ll have to decide whether to continue Johnson’s strategy of turning the chain into a collection of boutiques or return to a more traditional department-store model. Ullman will also have to consider whether to sell the company or break it up, said Dave Larcker, a corporate governance professor at the Stanford Graduate School of Business in Stanford, California.

“The board is going to have to get much more involved in the strategy of the company,” Larcker said. “People may attack the board, as well, for how this happened. This was a high-profile hire. For it to unravel this quickly is kind of terrifying.”

The Plano, Texas-based chain was so damaged under Johnson that Ullman will struggle to turn it around. On Feb. 27, J.C. Penney reported annual revenue dropped to $13 billion, the lowest since at least 1987. Johnson alienated the company’s core customers by doing away with sales and promotions and only recently began trying to win them back by putting discounts front and center again.

“There is a tremendous amount of cleaning up and rebuilding that has to take place,” Howard Gross, managing director of the retail and fashion practice at executive search firm Boyden in New York, said in a telephone interview.

Johnson’s appointment as CEO in November 2011 was greeted with much anticipation by analysts and investors. After all, he had helped Steve Jobs prove doubters wrong by turning Apple Inc.’s stores into a success with unrivaled sales per square foot. Johnson was expected to work similar feats at J.C. Penney, which was struggling for relevance. The shares surged 17 percent on June 14, 2011, the day Johnson’s hiring was announced, for the biggest gain in more than a decade.

Bill Ackman, whose Pershing Square Capital Management LP is the company’s largest investor, handpicked Johnson and championed his re-invention plans. Before Johnson unveiled his turnaround strategy in January 2012, Ackman vowed it would be the most important day for retailing in 25 years. At first investors were on board, and the shares routinely surged whenever Johnson spoke publicly.

Splashy Announcements

Johnson made a series of splashy announcements. One of the first was that J.C. Penney was taking a 17 percent stake in Martha Stewart Living Omnimedia Inc. with the aim of selling the lifestyle doyenne’s products. The bet later soured when Macy’s Inc., which already had an exclusive deal to sell Stewart-branded merchandise, sued J.C. Penney. The two sides continued to battle in a New York court yesterday.

Another move that would come back to bite Johnson: The decision to institute everyday low prices and get rid of the discounts and promotions that American shoppers have come to expect. A series of TV commercials, some starring Ellen Degeneres, sold J.C. Penney as a hip destination rather than focusing on specific merchandise and deals, deals, deals.

Johnson’s strategy of eliminating promotions was doomed from the start, said Allen Questrom, a former J.C. Penney CEO who retired from the retailer in 2004.

“I would have told him, ‘You can’t take a middle-market store in the middle of a recession and not have sales,’” Questrom said in an interview last month. “It’s never worked before. If you want to do that, you have to do it over a long period of time and certainly not in a recession, when people want value more than ever.”

Johnson’s failure is a blow for Ackman, who is now accepting Ullman as CEO, the very man he helped push out in 2011.

Ackman first disclosed his J.C. Penney stake in October 2010, when his $13 billion hedge-fund firm filed documents showing that it held a 16.5 percent stake in the retailer. Vornado Realty Trust, a real estate investment trust run by Steven Roth that has teamed up with Ackman in the past, simultaneously disclosed that it had acquired a 9.9 percent stake in J.C. Penney.

Ackman Stake

Ackman spent more than $1 billion to acquire 39 million common shares at an average cost of about $25.90 each. Pershing Square later raised its economic stake by entering into swap contracts on an additional 15.9 million J.C. Penney shares that would require the hedge fund to pay out cash to the extent the retailer’s stock price fell below $26.14.

Based on yesterday’s closing share price, Pershing Square has a loss on its J.C. Penney shares of about $390 million, or 39 percent. In addition, it has a partially realized loss of $164 million on the total return swaps it holds.

Ackman’s best shot at salvaging the investment may be to push the department store to go private, a move that may require additional capital. The retailer is now trading at a 73 percent discount to its annual revenue, the second-cheapest among U.S. department-store chains, according to data compiled by Bloomberg.

Because J.C. Penney also has the industry’s highest ratio of net debt to market value, a traditional leveraged buyout is unlikely, Morningstar Inc. said last month. Another option is to place some properties into a real estate investment trust, International Strategy & Investment Group LLC, said last month.

J.C. Penney’s setbacks have left its equity priced at 27 cents for each dollar of revenue, a valuation that lags behind Macy’s, Nordstrom Inc., Kohl’s Corp., Dillard’s Inc. and Saks Inc., data compiled by Bloomberg show.

Last week, Ackman abruptly stopped defending his man, saying at a conference that Johnson had made changes too quickly and called the turnaround “close to a disaster.”

Now it’s up to Ullman to stabilize the company. In his previous stint as CEO from 2004 to 2011, he breathed life into the chain with new brands such as Sephora and Liz Claiborne. Sales grew in 2005 and 2006, and the shares more than doubled through February 2007. Then came the downturn and a corresponding slide in sales. Ackman began pushing for changes in 2010.

Ullman “was caught in a business model at J.C. Penney that needed an injection of energy, and he brought in some new brands that were successful.” said Robin Lewis, a retail consultant in New York. “But perhaps he didn’t do it fast enough for shareholders and the board. He was struggling, and that’s when Ackman got involved.”

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